"Superfunding" is a term sometimes used to describe large 529 plan contributions using 5-year gift tax averaging described in section 529(c)(2)(B) of the Internal Revenue Code. It can be a great way to jumpstart a child's or grandchild's college savings account.
For those with significant assets, 5-year gift tax averaging offers income tax benefits and estate tax benefits. Consider the case of two grandparents with 10 grandchildren. Superfunding their 529 plan accounts would reduce their estate by $1.5 million in a single day without using any of their lifetime exemptions.
Tax law allows 5-year gift tax averaging only for gifting that involves 529 plans (and in rare situations, Coverdell education savings accounts). Here are a few rules and tips to keep in mind when considering superfunding a 529 plan.
1. Contributions to the beneficiary's 529 account must total more than $15,000 for the year
Don't even bother to posit a scenario where the 5-year gift tax averaging should be available on smaller contributions. (See number 8 below for an example of why you might wish you could elect 5-year treatment on a lesser amount.) It won't work.
2. Contribution to the beneficiary's 529 plan account cannot exceed $75,000 in a year
Well, actually, they can be more than $75,000. But only the first $75,000 is eligible for the gift-tax exclusion. If a taxpayer contributes $100,000, this year's gift is $40,000, consisting of (a) 20% of $75,000 ($15,000) plus (b) the excess of $100,000 over $75,000 ($25,000).
Assuming no other gifts are made during the year, the taxable gift after annual exclusion in this scenario would be $25,000. That amount is applied against the taxpayer's $11.4 million lifetime gift-and-estate tax exemption.
3. The elective amount is pro-rated over 5 years
Contributions between $15,001 and $75,000 are spread equally over 5 calendar years. That's 20% of the elective amount per year. No exceptions. No wiggle room.
For example, a taxpayer contributes $42,000 to a 529 plan and wants to apply it over 3 years at $15,000 per year. That won't work. The $42,000 will be applied $8,400 per year for 5 years. If no other gifts are made, the taxpayer is leaving $6,600 per year on the table as unused annual exclusion.
Here's another example. A taxpayer makes a $10,000 gift to a grandchild through a "Crummey" life insurance trust. She also makes a $65,000 contribution for that grandchild into a 529 plan, expecting to apply the $5,000 remaining from this year's annual exclusion, and leaving $15,000 for each of the next 4 years. That won't work either. The $65,000 contribution under a 5-year election is treated as a $13,000 gift each year, and this year's total gifts (including the $10,000 to the life insurance trust) will now be $23,000.
The most that could be contributed to the 529 plan this year without exceeding the annual exclusion after the Crummey trust contribution is $25,000 ($5,000 x 5 years).
4. The election is all or nothing
If a taxpayer applies 5-year gift tax averaging, all 529 plan contributions that are eligible for the election will be spread. At least that's the way the law reads. You cannot contribute $50,000, for example, and elect 5-year treatment on only $30,000. The instructions for the Form 709 Gift Tax Return require that a taxpayer must provide the total contributions in addition to the election amount.
5. A taxpayer can make the election more than once in a 5-year period.
The IRS hasn't specifically said this can be done, but there doesn't seem to be any reason why it should not be allowed. For example, if a taxpayer uses 5-year gift tax averaging on $50,000 of contributions made this year, the gift will be counted as $10,000 this year and $10,000 for each of the next 4 years.
Next year, the same taxpayer contributes $25,000 and makes the 5-year election again. The gift is $5,000 next year and $5,000 in each of the four subsequent years. Total gifts in Year 2 are $15,000, consisting of $10,000 from the Year 1 election, and $5,000 from the Year 2 election.
6. There is no such thing as a joint election
That's because there is no such thing as a joint gift-tax return. When two spouses each have made 529 plan contributions for a beneficiary that exceed $15,000 they will each have to file Form 709 to make the 5-year election. In many cases, only one spouse actually makes the 529 plan contributions, but when the spouses consent to "gift-splitting" they are each considered as making one-half of all gifts made that year.
So, keep in mind that any time a couple superfunds their 529 plan account with more than $75,000, two gift tax returns will have to be filed.
7. One spouse might want to make the election when the other spouse doesn't
But, why would anyone want to complicate their life that way? Maintaining a 5-year election spreadsheet would be a chore, to say the least. In the vast majority of cases, the spouses will want to do gift-splitting and make separate 5-year elections on eligible contributions. It won't matter who actually makes the contributions. (But, it could matter which spouse is named the 529 plan account owner, especially in the event of divorce later on.)
8. When the gift-tax annual exclusion increases, the 5-year election amount increases
The gift-tax annual exclusion increased from $14,000 to $15,000 in 2018 based on the automatic inflation adjustments, and so the maximum amount of contributions eligible for the 5-year election increased from $70,000 to $75,000.
If a taxpayer is already spreading a $70,000 contribution that he started in 2016, they can contribute an additional $1,000 to a 529 plan in 2019 and in 2020 without exceeding the new higher exclusion amount.
However, the taxpayer cannot contribute $5,000 in 2019 and make another 5-year election. Five-year gift tax averaging is available only when contributions for the year exceed $15,000. In this example a $15,000 contribution generates gifts of $3,000 per year, which puts them over the annual exclusion by $2,000:
$14,000 initial gift + $3,000 gift in 2019 = $17,000 total gifts in 2019
9. Dying too soon can still save estate taxes
An individual must live until January 1 of the fifth calendar year to "earn" the full 5-year annual exclusion. If they die during Year 4, 20% of the election amount (representing the Year 5 portion) must be included in her gross estate. However, any earnings in the 529 plan account remain outside of their taxable estate.
10. Be sure to consider other gifts made during the year
If all gifts were 529 plan gifts, the math of 5-year gift tax averaging is fairly straightforward. For anyone making non-529 plan gifts, things get trickier. If an individual is trying to stay within the $15,000 annual exclusion, a $2,000 gift of cash or stock reduces the allowance for 529 gifting to $13,000.
Superfunding now gets limited to $65,000 ($13,000 times 5), instead of $75,000. Financial advisors should never recommend clients make a $75,000 529 plan contribution WITHOUT FIRST asking about other gifts during the year. Even small gifts must be considered as there are no de minimis exceptions when it comes to the federal gift tax.
As an alternative to superfunding, gift givers may use up part of their lifetime gift and estate tax exemption. It is possible to fully fund a 529 plan account without having to pay gift taxes, since individuals are not subject gift tax or generation-skipping transfer tax (GST) unless the total amount of cash and properties they give away over the course of their lifetime exceeds $11.4 million.